Global economy: Rays of hope pierce thick clouds

London, March 11, 2013

By Alan Wheatley, Global Economics Correspondent

Global economic news is improving here and there, but a batch of data due this week is unlikely to shake financial markets' conviction that major central banks are not about to take away the punch bowl.

If anything, even more monetary easing could be in the pipeline.

A minority of policymakers at the Bank of England wants to expand its bond buying. The nominee to head the Bank of Japan is promising profound change to root out deflation.

Even the conservative European Central Bank (ECB) pondered a further interest rate cut last week after its staff forecast that the euro zone would not only remain in recession in 2013 for the second year in a row but would shrink by more than previously thought.

Extraordinarily loose global policy settings speak volumes about how much spare capacity there still is in the post-crisis world economy - despite Friday's surprisingly strong US job figures.

"My best guess is that the output gaps are sufficiently large in all the major economies that central banks can do additional stimulus if need be," said Derry Pickford, macro analyst at investment managers Ashburton in London.

LOTS OF SLACK

US retail sales are likely to have risen 0.5 percent in February, according to a Reuters poll of economists.

That's not bad on the surface, but it would be flat in real terms if forecasts of a 0.5 percent increase in consumer prices prove accurate. Both sales figures and prices are likely to have been lifted by higher gasoline prices.

Estimating output gaps is an imprecise science. But even if America's economy turns out to be closer than anticipated to reaching its inflationary speed limit, Pickford said this was a risk for 2014 and not for the second half of this year.

In a recent speech, Federal Reserve Vice-Chair Janet Yellen firmly quashed talk of an early withdrawal of stimulus.

Indeed, after the government reported that the US unemployment rate fell to a four-year low of 7.7 percent in February, traders of short-term US interest rate futures were still betting that the US central bank was more likely to raise rates in early 2015 than in late 2014.

What's more, Wall Street economists polled by Reuters after the jobs report said they expected the Fed to keep buying bonds through the end of this year.

Bruce Kasman, an economist with JP Morgan in New York, said he doubted the unemployment rate would fall much below 7.5 percent at any stage in 2013.

Consumers would have to absorb the shock of higher payroll taxes and job cuts triggered by across-the-board federal spending cuts after politicians in Washington failed to agree a long-term budget deal.

As a result, growth in non-farm payroll jobs was likely to slip to around 150,000 from the 191,000 average of the past three months. February's figure was 236,000. In short, the economy would not be displaying the consistency the Fed wants to see before it starts to row back from its ultra-loose stance.

"The numbers in the coming months will have a little bit of a hit from the tax-increase drag, and that will slow labour markets somewhat and will keep the Fed believing that we're going to take some time before we hit that escape velocity," Kasman said on a conference call.

DOLDRUMS

Across the Atlantic, industrial production is predicted to have fallen 0.1 percent in the euro zone and risen 0.1 percent in Britain during January.

"In our view, there is little doubt that central banks retain the capacity to do more, despite the size of their balance sheets and the low level of policy rates," Jens Larsen, chief European economist at Royal Bank of Canada in London, said in a note.

That was particularly true for the ECB, which kept policy on hold last week. "It could, if push came to shove, engage in an outright purchase programme of the kind in which the Bank of England has engaged," Larsen said.

He said the ECB also had some leeway to lower its main short-term interest rate - a course of action advocated on Friday by Christine Lagarde, the managing director of the International Monetary Fund.

Fundamentally, central banks would stick to accommodative policies because the world is awash in excess capacity and growth is being held back because governments and the private sector are reducing their debts, a process that Larsen said was not about to end soon.

Fraser Thompson with the McKinsey Global Institute said consumer deleveraging could last for years.

In Europe at least, he said, the solution was for governments to mount a concerted effort to remove roadblocks such as planning curbs that deter corporate capital spending.

"Private investment is likely to have to play a dominant role if we're going to have a serious economic rebound," Thompson said. - Reuters